Bird In Hand

What does 'Bird In Hand' mean

Bird in hand is a theory that postulates investors prefer dividends from a stock to potential capital gains because of the inherent uncertainty of the latter. Based on the adage a bird in the hand is worth two in the bush, the bird-in-hand theory states investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains.

BREAKING DOWN 'Bird In Hand'

The theory was developed by Myron Gordon and John Lintner as a counterpoint to the Modigliani-Miller dividend irrelevance theory, which maintains that investors are indifferent to whether their returns from holding a stock arise from dividends or capital gains. Under the bird-in-hand theory, stocks with high dividend payouts are sought by investors and consequently command a higher market price.

Dividend vs. Capital Gains Investing

Investing for capital gains is predicated largely on conjecture. An investor may gain an advantage in capital gains by conducting extensive company, market and macroeconomic research, but ultimately, the performance of a stock hinges on a host of factors completely out of the investor's control.

For this reason, capital gains investing represents the "two in the bush" side of the old adage. Investors chase capital gains because of the possibility of those gains being large and making the investor rich, but the possibility is just as real that capital gains are nonexistent or, worse, negative.

Broad stock market indices such as the Dow Jones Industrial Average (DJIA) and the Standard & Poor's (S&P) 500 have averaged 9 to 10% in annual returns over the long term. It is very difficult to find dividends that high. Even stocks in notoriously high-dividend industries such as utilities and telecommunications tend to top out at 4 to 5%. However, if a company has been paying a dividend yield of, say, 5% for many years, receiving that return in a given year is much more of a sure thing than earning 9 or 10% in capital gains.

During years such as 2001 and 2008, the broad stock market indices posted big losses, despite trending upward over the long term. In years such as these, dividend income is more reliable and secure, hence being dubbed the "bird in hand."

Disadvantages of the Bird in Hand

Legendary investor Warren Buffett once opined that in investing, what is comfortable is rarely profitable. Dividend investing at 4 to 5% per year provides near-guaranteed returns and security, but over the long term, the pure dividend investor has earned far less money than the pure capital gains investor. Moreover, during some years, such as the late 1970s, dividend income, while secure and comfortable, has been insufficient even to keep pace with inflation.